Cash In on Amazon’s Head Fake

AMZN could jump to its feet after a recent failed breakdown

Plagued by persistent weakness in Apple (NASDAQ:AAPL), the Powershares QQQ Trust (NASDAQ:QQQ) — the world’s most popular technology ETF — has been lagging the S&P 500 ever since our current bull run kicked off last November.

But that changed last week. Strength from a consortium of tech companies, from AAPL and Google (NASDAQ:GOOG) to Microsoft (NASDAQ:MSFT) and Intel (NASDAQ:INTC), led to a resurrection in the tech space.

Click to Enlarge As shown in the background of the accompanying chart, the QQQ:SPY ratio recently turned up, breaking a multi-month downtrend line in the process. Since technology lies on the growth/offensive end of the sector spectrum, its renewed leadership marks a positive shift for the ongoing bull market in equities.

One popular company that has been noticeably absent from the tech comeback is Amazon (NASDAQ:AMZN), which has spent the entirety of 2013 mired in a trading range between $275 and $255.

Recently, the online retailer breached its lower support zone in a breakdown attempt. With last week’s rebound back above the $255 zone, however, it appears the breakdown might have failed.

If we subscribe to the old notion that “from failed moves come fast moves,” then perhaps last week’s failed breakdown will result in a fast move to the upside in AMZN.

The current risk-reward seems to favor such a bullish bet. With the stock trading in the $255 area, an exit point below $245 yields $10 of risk, while a profit target at the north end of its trading range ($275) yields $20 of potential reward.

Another indicator we might appeal to in building our bullish case is Amazon’s correlation with the overall tech sector shown in the bottom panel of the chart above.

During the past eight months, the correlation between AMZN and QQQ has been strongly positive with only a few drops into negative territory. A disconnect between the price action of AMZN and QQQ over the past few weeks has led the correlation to fall below zero yet again. If history is any indication, however, the divergence shouldn’t persist. If the tech sector continues its newfound leadership role, it’s altogether likely that it pulls AMZN higher with it.

One way to profit from Amazon’s failed breakdown is selling the June 245-240 put spread for $1.50 credit. Consider it a bet that AMZN will remain above $245 by June expiration. If correct, the put spread will expire worthless, allowing you to pocket the initial $1.50 received at trade entry. The max risk is limited to the distance between strikes minus the net credit, or $3.50.

In timing your entry, I suggest waiting for AMZN to form some type of bullish reversal candle or at least form an intraday uptrend. So far in early Monday morning trading, the stock has too much weakness to merit pulling the trigger on the trade.

As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.